A Tablet for the Long Term

If projections are accurate, the Kindle Fire could sell 5 million units by the end of the year. That's great news for Amazon.com (Nasdaq: AMZN  ) , which might have been worried that its tablet couldn't catch up with Apple's (Nasdaq: AAPL  ) monster iPad numbers. The bigger question now isn't whether the Kindle Fire can catch the attention of fickle tablet consumers, but whether it can actually make money off electronics that it's selling at a loss. If Amazon's strategy bears fruit, it will -- and it could be substantial.

Loss-leader
Selling hardware at a loss to make money elsewhere isn't a new idea. Game consoles have taken the same approach for years. Amazon, with a vast digital repository of e-books and perhaps the largest variety of items for sale anywhere on Earth, is playing to its strengths -- not Apple's. The Fire is a content and sales ecosystem, not a high-powered portable system. I first wrote about this possibility the day the Fire was unveiled to the public, but other Fools laughed at the idea.

Well, with at least 500,000 pre-orders, who's laughing now? Bwa-ha-ha-ha-ha! Ahem.

Long-term planning
The question now turns to just how much Amazon could make off its Fires. In an interview with Wired this month, Jeff Bezos mentioned that he has a longer time horizon than most competitors because he's willing to plan seven years into the future. That sort of thinking is evident in its Kindle strategy. Did you know that e-book readers read more often, on average, than readers of print books? Did you know that Amazon customers buy over three times as many books after they purchase a Kindle as they did before? Jeff Bezos certainly knows.

The Fire is best viewed as an electronic storefront. With Prime subscriptions, e-book sales, shipped-goods sales, app downloads, and other digital content sales, the Fire could make more than you might expect.



Sources: Amazon, GigaOM, The Wall Street Journal, and author's calculations.

Let's break this down. A study cited by The Wall Street Journal said that e-reader owners read 2.6 books in a month, compared to 1.9 for print readers. By that measure, the chart is on the conservative side, since it's the average revenue Amazon would make off two e-books a month, based on typical e-book prices and Amazon's own royalty rates.

Storefront sales were based off a GigaOM figure that claimed Amazon's customers spend an average of $245 a year -- I divided that by half (assuming that much of those purchases would be on Kindles) and conservatively estimated that this new figure would only be reached by half the Fire's users -- this figure can include app sales and digital content sales tailored to the Fire. I also assumed a third of the Fire's users might get a Prime subscription.

This is hardly an exact estimate, but I believe the numbers are highly conservative and could be exceeded when actual Fire-based sales numbers come available.

The snowball
To put that in perspective, it's still a good deal lower than Apple's gross profit off a single iPad 2 with 32 gigabytes of RAM, which is about $290. The Fire won't be boasting great margins when it's sold, but if it really takes off, it could have strong residual effects across Amazon's entire line of products and services.



Sources: Amazon, GigaOM, The Wall Street Journal, and author's calculations.

Twenty-eight million, by the way, is the number of iPads Apple has sold since they first released the tablets in 2010. I don't see the Fire as a direct competitor, and neither does my Foolish colleague Rick Munarriz, who calls it "the Camry of tablets." That's not a bad thing. Last year the Camry had nearly 17 times the sales of Porsche's entire lineup. JPMorgan analyst Doug Anmuth predicts that Amazon will sell 20 million Fires next year. That might be on the low end -- many early iPad projections underestimated the device's appeal. Unlike Apple's iPads, these revenue projections are recurring. A single Fire should bring Amazon years of purchases.

Fear of getting burned
This could be very bad news for other companies, however. As Prime gains prominence, Netflix (Nasdaq: NFLX  ) could see subscribers switch to a service that's likely to play an important role in the tablet's appeal. eBay (Nasdaq: EBAY  ) would probably be hurt as well, and Liberty Interactive (Nasdaq: LINTA  ) could see sales siphoned off of its popular QVC site.

It's reasonably certain that a popular Fire at $199 would dent sales of a $249 Barnes and Noble (NYSE: BKS  ) Nook tablet. B&N doesn't have the content ecosystem Amazon's built, which puts its slightly more-expensive entry-level tab at a big disadvantage. You can wave goodbye to the Research In Motion (Nasdaq: RIMM  ) PlayBook as well, but that tablet has been underperforming for a while.

Don't worry too much about Apple, though. Porsche doesn't care about the Camry's sales.

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Fool contributor Alex Planes holds no stake in any company mentioned here. Add him on Google+ or follow him on Twitter for more insights and attempted wisdom. The Motley Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of Apple, Amazon.com, Netflix, and eBay. Motley Fool newsletter services have also recommended creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (11) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 05, 2011, at 10:53 AM, bsimpsen wrote:

    Your Camry/Porsche analogy makes no sense to me. Unless you expect the Kindle Fire to vastly outsell the iPad soon. I don't see that happening. I think it's more like Apple as the Camry and Kindle Fire as the Chevy Malibu (I'm not auto expert enough to know if the sales volumes of those two cars are in proper proportion, but you get my drift).

  • Report this Comment On December 05, 2011, at 11:02 AM, leonhart03 wrote:

    No kidding... it's closer to consider Camry/Porsche against the Kindle/Nook Tablet. Nook really is a LOT better performing tablet than the Fire. I don't want a device that can't run its "amazing" selection of apps worth a darn. I'm more than patient enough to see BN's content selection explode in the next few months, when developers realize how much more capable the Nook is for their content. Another win for the fools.

  • Report this Comment On December 05, 2011, at 11:14 AM, SkippyJohnJones wrote:

    I've read this line of logic several times, by several writers, on several sites. While it may bear fruit for Amazon, I have a few key issues:

    1) Why the contrast of Amazon's content vs. Apple's? It's as though iPad users don't buy accessories, apps, books, extended warranties, etc. Other than books, Amazon doesn't hold a larger library than Apple. I agree that Amazon is going to sell a lot of content, but you go a step to far in suggesting that Apple doesn't. Apple provides us with a pretty good breakdown of what they sell (a lot), how much it's worth, and the cost of maintaining a storefront. At the end of the day, there isn't huge margin in content because...

    2) None of the content is proprietary. They don't make the movies, books, songs, or apps themselves. They take 30% of gross, but do a lot of work for their share. In fact, Apple's presence in e-publishing has reportedly forced contraction in Amazon's margins. Now maybe Amazon runs its storefront more efficiently, but we aren't talking about...

    3) Video games. This model works well with consoles, which generate exclusive $60 games that sell in the millions of units. I've read the console comparison multiple times also, but the margin is so vastly different that it just doesn't hold water. Also, video game consoles are...

    4) Rarely upgraded. A life cycle is typically 5-6 years. This long upgrade cycle creates incentive for users to amass large content libraries that typically don't port to the newer generation. Games are iterated for each console, and repurchased at full price. The same cannot be said of books, which is Amazon's strength. Fire owners are likely to upgrade on a much more rapid cycle. 5 years ago, modern multi-touch smartphones didn't exist. Today, the typical user is working through their second contract. Every one of Amazon's competitors depends on a quick upgrade cycle, and Amazon is in the unusual position of having to convince its customers NOT to upgrade every couple years to its latest and greatest model.

  • Report this Comment On December 05, 2011, at 11:21 AM, SkippyJohnJones wrote:

    Also, Prime is a loss leader. It erases revenue on media content, and drains margin in favor of revenue on general merchandise with free shipping. The product pulls eyeballs to the site as a primary search (ahead of Google), but it becomes less valuable to the company the more a user embraces it. The video catalog that is included with membership suffers the same economics that have brought Netflix tumbling back to earth, and now the company is throwing in free book rentals that it often has to buy from publishers with each "copy" rented.

    So Fire (loss leader) is being used in hopes of selling Prime (loss leader) so that users will buy more merchandise at low single digit margins with subsidized shipping.

    Oh, and sales tax is lurking...

  • Report this Comment On December 05, 2011, at 11:29 AM, mardams wrote:

    Well, this is a positive news for Amazon.com and its investors that only shows that they are a strong competitor in the Retail industry. As of 2011-06-30, they reported that they a profit of $530 million against $19.79 billion in revenue.

    Moreover, this is a good sign that investors can continue on their trading as the Kindle Fire’s sales is increasing. I believe that the tablet will go a long way that in return could help boost the profit of Amazon.com and attract more investors with its health balance sheet.

  • Report this Comment On December 05, 2011, at 1:35 PM, lucasmonger wrote:

    I played with a Kindle Fire demo model over the weekend at a local mall, and I was surprised that Amazon only focused on books, music, and videos on the device, seemingly forgetting all the other stuff that you can purchase from Amazon. Maybe that was an artifact of the device being a demo model, but I fully expected the full-up Amazon store (like the Amazon App on the iPad) to pervasively steer all of your potential purchases to the Amazon portal. Seems like a missed opportunity to me.

  • Report this Comment On December 05, 2011, at 3:39 PM, Notabillionaire wrote:

    So why can't you use Gmail on a Kindle Fire?

    http://www.billionairechronicles.net/billionaire-news/open-l...

  • Report this Comment On December 05, 2011, at 4:00 PM, foolindeed1 wrote:

    Hello, Melissa, I think that Kindle Fire is neither a tablet (too underpowered and lacks features) nor eReader (LCD screen and poor battery life.) It is rather a $200 device for shopping on Amazon web site. If you believe almost 900 people that left 1-2 star reviews on Amazon site for Kindle Fire and drop all 5-start reviews from Amazon employees and read middle ground 3-start reviews you'll understand that it is a deeply flawed device. It is confirmed at this time that many Kindle Fire units have faulty Wi-Fi and people have a lot of issues connecting to internet according to many user reviews. Other issues are that it runs hot to touch, video playback is jerky, touch screen is not responsive and it takes 2-3 touches to register, power button placement is very poor and is prone to accidental power off, all the hype of Silk browser is a fake where the browsing is actually slower than on other Android tablets, etc.

    Take a look at recently released Nook Tablet - it's been getting rave reviews and it is the best device in it's class - much better than Kindle Fire. It's got Netflix, Hulu, Pandora, Angry Brids, etc., the best battery life, the best screen, double the RAM and space for apps/photos/movies, microSD slot, a microphone for Skype, and physical volume controls on the side (neither of those is on Kindle Fire.)

  • Report this Comment On December 05, 2011, at 4:30 PM, TMFBiggles wrote:

    I respect everyone's opinions on this matter, and I personally have mixed feelings. A big reason why I ran these numbers was to see what Amazon COULD earn, not what I think it WILL. Call it a thought experiment on a bullish case. If you disagree, you're welcome to.

    I think these estimates could be met, but they may not -- it'll probably take at least until Amazon's Q1 report next year to get a more accurate bead on its impact on the company, since everyone expects it to be a big loss leader in the holiday sales period.

    Couple quick direct responses:

    @ Camry/Porsche analogies -

    While this might be a bit of a stretch, early reporting appears to bear out that the Kindle Fire is off to a faster start than the iPad. If this doesn't hold up over a longer non-holiday timeline, then yes, it could be misplaced. Maybe call Apple a BMW instead of a Porsche.

    @ SkippyJohnJones -

    1. Mainly because Amazon is releasing this tablet as a content sales portal for a loss per unit, while Apple's tablet is a hardware sale with a nice profit. Their content sales are a bonus, but Amazon's are a requirement for success.

    2, 3, 4. I agree that these are valid concerns. I really like your analysis, because it puts into words some bearish thoughts that were rattling around the back of my head during the writing.

    The console comparison is interesting because (at least from my understanding) modern game consoles are backwards compatible, so you should be able to play games from the PS2 on your PS3, but that's rarely the reason why people get the new iterations of games. New content is new content, regardless of whether it's a book or a video game, and people who want to read something else (or watch something else, or buy something else...) are probably not going to restrict themselves just because they might have bought a different e-book the week before.

    The double loss leader point is also interesting, but I'd like to know where you came up with the numbers that point to Prime being a loss leader.

    - Alex

  • Report this Comment On December 05, 2011, at 9:42 PM, kthup wrote:

    Nook tablet is not "entry level". Nook color is the "entry level" nook. At $199, that is the appropriate device to compare to the Fire. Nook tablet is the luxury vehicle. Both outperform the Fire in most reviews. The ongoing ignorance of these writers despite all the readers who call them out on their blatant, poorly researched biases is just mind-boggling.

  • Report this Comment On December 06, 2011, at 11:26 AM, SkippyJohnJones wrote:

    @TMFBiggles - thanks for your comment. It's always nice to get a response from the author.

    -Most modern game consoles are backwards compatible, but with some limitations. Newer systems typically use different controllers than their predecessors, so compatibility can be affected. But my point was more about software titles. Nintendo, for example, is able to sell Mario and Zelda titles with each generation of its consoles, taking advantage of improved graphics and controller UI. These same titles likely would not sell nearly as well if they were released only as updates to existing franchises on existing hardware. Once users migrate to the new system, they are typically happy to fork over hundreds on software that largely does exactly what the old games did.

    Your point is still well taken though. There is an infinite supply of reading material available, and books typically never get touched once they have been read.

    -I have no data on the Prime, just an opinion. It is an odd business in that margin DECREASES with usage. The goal of Amazon is to get users to sign up, then limit their consumption. Think about video alone; at $79 annually, the service is is 18% cheaper than the Netflix product. Any article about Netflix points to an exponential increase in content cost, and I can't imagine Amazon will be able to work appreciably better deals. Without a full library, the service suffers; this is a lose/lose scenario.

    In addition to video, Amazon is lumping in "free" book rentals (which it often has to buy and subsidize), at the expense of direct sales of ebooks. This is a bold move, but I can't imagine publishers are supporting it. Amazon is on an island, which means margin compression.

    Now, go back to the free shipping. This service works, but isn't compelling enough as a standalone at $79 to rope in any except for high-volume online shoppers. I would guess that many of these people already frequent Amazon. My wife is an avid deal-hunter. Her idea of "winning" is being allowed to combine several offers simultaneously. She subscribes to prime, and I have noticed three patterns in her behavior:

    1) She favors Amazon for large, bulky items. On these purchases, the free shipping is a big deal. Throw in the opportunity to not pay tax upfront, and she's in heaven.

    2) She is more than willing to buy one item at a time. Because she isn't managing the shipping cost, she makes no effort to combine purchases.

    3) The big losers are Amazon affiliate sellers. If she can't buy something from Amazon direct (Prime eligible), her reflex is to check Google. She won't consider anything sold through Amazon's network until all other options have been exhausted.

    My wife is an extreme example, but I would think that some element of her behavior is repeated among most Prime users. My theory is that Amazon is making the long play. They are essentially buying users' loyalty to get ecosystem lock-in. Apple was fortunate enough to get loyalty organically, but Amazon is very late to the hardware game; they need to give incentives. They want scale enough to be formidable. They want to attract app developers, sell display ads across the web, own user data, etc. To achieve this, they need massive scale and loyalty.

    I love Amazon, and think they will continue to be successful. But I'm VERY skeptical about the whole Fire/Prime revenue model. It's hard to fathom how the market values the company at more than 100x trailing earnings, even in the face of downward forward guidance. It's the ultimate "don't buy" at this level; a great company that just isn't worth what people are paying today.

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